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Delaware Chancery Court Clarifies Limits of §220 Record Confidentiality

In a December 31, 2014 letter, the Delaware Chancery Court clarified that financial information some previously ordered produced by Winmill & Co. Incorporated (“Winmill”) was subject to confidentiality protection. The Ravenswood Inv. Co. v. Winmill & Co., C.A. No. 7048-VCN, (Del. Ch. Dec. 31, 2014). Specifically, the court concluded the financial statements produced by Winmill would remain confidential for one year following the production to Ravenswood Investment Co., L.P. (“Ravenswood”).

In Ravenswood Investment Co., L.P. v. Winmill & Co., C.A. No. 7048-VCN, 2014 BL 152126 (Del. Ch. May 30, 2014), Ravenswood initiated the suit seeking access to requested books, records, and financial statements pursuant to 8 Del. C. §220. Winmill proposed a trading restriction that would prohibit Ravenswood from trading in Winmill stock as a condition of inspection. The court, however, declined to impose the restriction, finding that the proposal was contrary to Delaware law and stockholders’ fundamental rights. The court held that Ravenswood did not meet the clear evidence standard of bad faith and, as a result, each party would bear the cost of its own attorneys’ fees.

In producing information, Winmill proposed the information produced remain confidential until it (a) became publicly available, (b) one year after Ravenswood received the documents, or (c) four years from the date of the document. Ravenswood objected to this proposal, wanting documents older than one year to be free from confidentiality restrictions. Winmill requested that Ravenswood’s access to books and records be conditioned upon an indemnification undertaking. Ravenswood objected and the matter returned to the Chancery Court.

The court concluded some confidentiality protection was appropriate. While difficult to establish the “correct” moment in time to treat information as public, the court found one year after the production to Ravenswood was a reasonable amount of time. Additionally, the court clarified that financial information did not warrant confidential treatment after three years. The court concluded that to add an indemnification condition to a right provided by Section 220 would unduly impair a shareholder’s rights.

The primary materials for this case may be found on the DU Corporate Governance website


Bourbonnais v. Ameriprise Fin. Servs. Inc.: Securities Fraud Investigation 

In Bourbonnais v. Ameriprise Financial Services., Inc., No. 14-C-966, 2015 BL 47543 (E.D. Wis. Feb. 24, 2015), Thomas and Donna Tesch and William Bourbonnais (“Plaintiffs”) filed a class action suit against financial advisor, Paul Renard, SII Investments, Inc., and Ameriprise Financial Services, Inc. (together, the “Defendants”), alleging securities fraud. Plaintiffs asserted that the Defendants violated Section10(b) of the Securities Exchange Act and Rule 10b-5 thereunder.  Plaintiffs also contended the Defendants violated the Wisconsin Uniform Securities Law, the Wisconsin Organized Crime Control Act, and acted with negligence.

According to the complaint, Renard was a registered broker with Ameriprise Financial Services and SII Investments from 1998 until 2013. He allegedly sold Plaintiffs non-traditional exchange-traded funds (“ETFs”).  Specifically, the complaint asserted that Renard sold multiple leveraged and inverse ETFs in approximately $100,000 increments and that that the Plaintiffs held them for anywhere between two and four years.  Ultimately, the Plaintiffs lost most of their investments in the instruments.

Non-traditional ETFs “are leveraged or inverse ETFs that seek to deliver multiples of the daily performance of the index or benchmark they track.” According to Plaintiffs, these securities generally have an investment objective period of a single day and allegedly are not suitable for retail investors “who plan to hold them for longer than one trading session, particularly in volatile markets.”   

The complaint alleged Renard had no legal justification for recommending the ETFs and that he violated Ameriprise policy by soliciting the investment. Moreover, Renard allegedly testified that Ameriprise employees directed him to solicit and then report the transaction as unsolicited. Plaintiffs also asserted that SII Investments failed to oversee Renard and knew that his customers were losing money. The plaintiff class termed themselves “ordinary people” who sought low risk accounts and that the brokers involved selected accounts that were not suitable for retail investors. Accordingly, the complaint alleged that SII failed to establish a system to properly monitor and advise the plaintiffs of the suitability of their accounts.

The Defendants moved to dismiss for failure to state a claim, to strike the class, and to arbitrate. They asserted that the plaintiffs failed to plead their claims with the particularity required for fraud charges under Rule 9(b) and the Private Securities Litigation Reform Act of 1995.

Federal rule of Civil Procedure 12(b)(6) requires the court to accept well-pleaded factual allegations.  Moreover, Rule (8)(a) requires the complaint to include a short statement showing entitlement to relief and Rule 9(b) requires claims of fraud to be pled with particularity. Under the Private Securities Litigation Reform Act, the complaint must specify each alleged misleading statement and provide an explanation of how it is misleading.  Furthermore it requires the plaintiff to “state with particularity” facts that provide strong support that the defendant purposely committed fraud.

The court granted the Defendant’s motion to dismiss with leave for Plaintiffs to file an amended complaint. The court found Plaintiffs failed to state sufficiently particularized allegations.  See Id. (“In truth, Plaintiffs do not really dispute the defendants' assertion that the complaint fails to identify individual omissions or misrepresentations with particularity.”). 

The court, however, indicated the belief that Plaintiff would be able to meet this burden with respect to at least some of the Defendants.  Id. (“It appears clear that Plaintiffs will be able to state a § 10(b) claim with the required particularity directly against at least Renard and perhaps under principles of respondeat superior or apparent authority against Ameriprise and SII.”).   

The primary materials for this case can be found on the DU Corporate Governance Site


SEC v. Tavella: Court Grants SEC’s Motion for Default Judgment And Gives SEC Opportunity to Supplement Contested Remedies

In SEC v. Tavella, No. 13 Civ. 4609 (NRB), 2015 BL 1982 (S.D.N.Y. Jan. 06, 2015), the United States District Court for the Southern District of New York granted the motion by the Securities and Exchange Commission (SEC) for default judgment against eight Argentinians for failure to respond to an SEC action for numerous securities violations and granted the SEC the opportunity to supplement its remedial request for disgorgement of prejudgment interest.

According to the allegations in the complaint, the eight Argentinian defendants (“Defendants”) were involved in numerous violations of American securities law. The securities in question were distributed by Biozoom (formerly known as Entertainment Arts), a penny stock company traded on the OTCBB. Biozoom represented its stock was divided among 3 corporate officers and 34 outside investors. In May 2009, Medford Financial purchased all of the shares. Biozoom, however, disclosed only the corporate officers had sold and that outside investors maintained their investment in Biozoom. In October 2012, Medford Financial announced the sale of 39,600,000 to Le Mond Capital, but actually sold 59,730,000 shares. 

Between January and May 2013, according to the SEC, Defendants opened accounts at U.S. broker-dealers making combined deposits totaling 15,685,000 shares. Defendants represented that the shares were purchased from the original 34 outside investors or persons who had acquired shares from these investors when in fact those shares had been conveyed to Medford Financial years earlier. Eventually, “Biozoom and other entities began to tout that Biozoom had ‘created the world's first portable, handheld consumer device' to instantly and non-invasively measure certain biomarkers’” and as a result of the campaign, shares underwent a “dramatic increase” and eventually “peaked at over $4 per share.” 

In May 2013, Defendants allegedly began selling shares of Biozoom in the public market. In June 2013, a number of the Defendants sought to wire proceeds to foreign accounts. Shortly thereafter, the SEC issued an order to suspend trading of Biozoom securities.

On July 3, 2013, the SEC commenced this action, seeking a temporary restraining order and a freeze on Defendants’ Biozoom shares and sales proceeds. Defendants retained two separate American attorneys, both of whom withdrew before the filing of the motion for default judgment. Defendants failed to respond to the complaint despite multiple extensions. The clerk of the court then certified Defendants’ default under FRCP 55(a), citing prolonged inaction.   

The SEC submitted a request for four separate remedies: permanent injunction, disgorgement of illegal proceeds, civil penalties, and disgorgement of prejudgment interest. The court approved a permanent injunction finding Defendants possessed a “substantial likelihood of future violations of illegal securities conduct.” The court agreed Defendants’ misrepresentations demonstrated scienter and that their violations demonstrated systematic wrongdoing. The court also approved the request for disgorgement of illegal proceeds. The court did, however, amend the amounts to be disgorged for four of the eight defendants due to calculation errors.

Civil penalties were also awarded, but the court reduced the amounts sought by the SEC. The court noted that, without more information, the role of each Defendant in the Biozoom scheme was left unclear. The court reduced penalties to $160,000 per Defendant, citing inadequate evidence of culpability necessary to  warrant penalties as high as the requested $2 to $6.2 million per Defendant.

The last remedy sought was disgorgement of prejudgment interest. The court had the discretion to require disgorgement of prejudgment interest in order to deprive defendants of the benefit of holding their illicit gains over time. When utilizing this remedy, courts generally use the IRS underpayment rate to calculate the applicable interest rate.

Because the funds had been subject to a freeze order, Defendants were already denied access to those assets. The SEC did not assert facts indicating Defendants had violated the freeze order in a manner that provided improper access to the proceeds.  As a result, the court deferred any decision on the imposition of prejudgment interest until after the Agency had “an opportunity to establish the actual amount of the returns, if any, that have accumulated on the frozen assets" or to show the Defendants had violated the asset freeze.  

The primary materials for this case may be found on the DU Corporate Governance website. 


Two Cases with Possible Implications for Corporate By-Laws

Two recent cases in Delaware has possible implications for corporate by-laws and the how corporations attempt to control both the type of proceedings parties must agree to and the forum in which parties must proceed.

The Delaware Supreme Court just added more ammunition to those favoring arbitration by applying for the first time the McWane doctrine (also known as the first-filed rule and articulated in McWane Cast Iron Pipe Corp. v. McDowell-Wellman Eng’g Co., 263 A.2d 281 (Del. 1970)) to dismiss an action because an arbitration proceeding had been earlier-filed.  In LG Electronics, Inc. v. InterDigital Communications, Inc., No. 475, 2014 (Del. Supr., April 14, 2015).  The McWane doctrine states that “litigation should be confined to the forum in which it is first commenced, and a defendant should not be permitted to defeat the plaintiff’s choice of forum in a pending suit by commencing litigation involving the same cause of action in another jurisdiction of its own choosing.‟

In LG Electronics, Chancellor Laster held that the Court could exercise its discretion under McWane “freely in favor of the stay when there is a prior action pending elsewhere, in a court capable of doing prompt and complete justice, involving the same parties and the same issues.”

The facts were somewhat unusual as there was no certainty as to whether the parties had actually agreed to arbitrate.  This ambiguity allowed the Court to find that the case presented “the rare instance when both the arbitral tribunal and the court have jurisdiction such that McWane could apply.”

LG argued that McWane could not apply because an arbitration proceed did not constitute a “prior action” under McWane –and in fact, no Delaware court had ever applied McWane to dismiss a lawsuit in favor of first-filed arbitration. The Court disagreed, finding that arbitral tribunal could provide “prompt and complete justice,” and noting that the interests of justice are better served if the tribunal deciding the overall matter in the first instance determines procedural disputes like the instant one. “Allowing parties to seek judicial review every time an arbitrator rules on—or, as in this case, declines to rule on—a procedural issue would frustrate the arbitral process.”

The decision in LG Electronics should be read together with the Chancery Court’s opinion in UtiliPath, LLC v. Hayes, Del. Ch., No. 9922-VCP, 4/15/15) finding that McWane does not apply if the parties agree in their contract that Delaware courts have jurisdiction over the dispute pursuant to a non-exclusive forum selection clause.  The clause at issue read


In UtiliPath there was a prior-pending action in the Eastern District of Pennsylvania when an action was filed in Delaware.  In light of above forum-selection language, Vice Chancellor Donald F. Parsons Jr. found that he was precluded from dismissing the lawsuit on McWane grounds because the parties clearly and unambiguously agreed that jurisdiction and venue would properly lie in the chancery court pursuant to a non-exclusive forum selection clause in the redemption agreement.

Consider the impact of these decisions taken together and what they may mean for corporate by-laws. Forum selection by-laws are receiving strong support in both Delaware courts and its legislature.  Corporations will likely now seek to adopt by-laws that require at least non-exclusive Delaware forum selection.  If they do, under Utilipath, first-filing in another jurisdiction will not prevent a Delaware filing.  Further, the strong support of arbitration shown by both the Delaware legislature in its passing of the Rapid Arbitration Act and the Delaware courts in LG Electronics suggests that by-laws requiring arbitration stand a strong chance of success –particularly given Boilermakers Local 154 Retirement Fund v. Chevron Corp., discussed here and here.


Special Projects Segment: The Proposed Crowdfunding Rules for Non-Accredited Investors and the Potential Associated Costs for Small Issuers

We are discussing possible rulemaking for equity crowdfunding under the JOBS Act.

One of the overall issues with the Proposed Crowdfunding Rules before the Securities and Exchange Commission (“SEC”) is the potential cost to those small issuers who might seek to take advantage of raising money through this type of offering. In particular, the proposed financial statement disclosures required pursuant to § 227.201(t) may cause such an offering to be cost prohibitive to many small issuers.

Under § 227.201(t), if the issuer’s aggregated offerings pursuant to § 4(a)(6) of the Securities Act of 1933 during the preceding 12 month period: (i) are less than or equal to $100,000, then the issuer’s principal executive officer must certify that the financial statements are true and complete in all material respects; (ii) exceed $100,000 but are $500,000 or less, then the issuer’s financial statements must be reviewed by an independent public accountant; and (iii) exceed $500,000, then the issuer’s financial statements must be audited by an independent public accountant. Under all three scenarios, the issuer must provide four financial statements: balance sheet, income statement, statement of cash flows, and statement of changes in stockholder’s equity. The issuer must provide those financial statements for the two most recent fiscal years or since the issuer’s inception. Additionally, the financial statements must include related footnotes and be prepared in accordance with Generally Accepted Accounting Principles (“GAAP”).

For an issuer that plans to raise $100,000 or less, the requirement that the principal executive officer certifies the financial statements as true and correct does not create an added expense. However, once an issuer decides to raise more than $100,000, additional costs are imminent. According to a 2014 survey by the Financial Executives Research Foundation, the average audit cost for a private company was $174,858 in 2013, an increase of 3.7% from 2012. Crowdfund, CPA, a company that specializes in helping issuers find a CPA firm that specializes in crowdfunding offerings and can provide the required “review” or “audit” service, estimates that a large public accounting firm charges a minimum of $15,000 for an audit, but the audit fee range for a mid-sized company is $50,000-$150,000. Crowfund, CPA, also estimates that the minimum cost for a financial statement review is $5,000.

While it is difficult to pinpoint the actual cost of a financial statement review or audit because each issuer, its business, and financial condition is unique, what is abundantly clear is that requiring an issuer to undertake a review or an audit under the Proposed Crowdfunding Rules could be quite cost prohibitive. Requiring a small issuer to spend a minimum of $5,000 for a financial statement review before it can seek to raise a minimum of $100,001 and up to a maximum of $500,000 is a significant upfront investment. Even more concerning is the potential up front cost of an audit for an issuer seeking to raise more than $500,000. These potential costs may well prevent many small issuers from taking advantage of the crowdfunding rules – rules that were proposed to grant such issuers easier access to the capital markets. 


BATS Exchange Open Letter: Calling for Lower Access Fees, More Disclosure

In early January, BATS Global Markets, Inc. (“BATS”), the third largest U.S. equity market operating four equities exchanges, suggested significant changes to the U.S. market structure in an open letter to the U.S. securities industry (“the industry”). BATS also indicated that it would petition the Securities and Exchange Commission (“SEC”) to implement its proposed changes. 

BATS suggested open and constructive dialog about potential market structure between industry and the SEC as a key factor in improving the U.S. equity market for all investors, while still providing for appropriate competition among markets and market participants. BATS also noted the growing concern within the industry regarding the amount of trading done away from the displayed exchanges and the incentives brokers received for routing orders to one destination over another.  

Some market professionals have advocated for a “grand compromise” that would impose dramatic regulatory change in the form of a trade-at prohibition. This would force order flow to the exchanges in order to decrease access fees and ban exchange rebates for market participants. BATS believes this compromise would ultimately be harmful and more expensive to end investors. As the letter states:

BATS believes that a “grand compromise” between industry professionals would ultimately be harmful to end investors. While exchanges, including BATS, would stand to benefit from increased volume directed to them, and brokers would benefit from a reduction in exchange fees, investors will likely pay more both in the form of potentially wider spreads as well as fewer and inferior execution choices resulting from restrictions on competition.

As an alternative, BATS advocated for regulatory changes in the following areas: Access Fees, Order Handling Transparency, Small Trading Centers, and a revision to Regulation NMS. 

BATS favors a reduction in the access fee currently imposed in Regulation NMS. The Exchange proposed a reduction of close to 80% for certain liquid securities. BATS recommended that any liquidity rebate be less for highly liquid securities. It is proposed an access fee reduction for the most liquid securities from 30 cents per 100 shares ($0.0030) down to 5 cents per 100 shares ($0.0005). For less liquid securities, access fee caps would be tiered based on a security’s characteristics. BATS argued that this approach would preserve the benefits of the current market structure while providing more opportunities to improve the trading experience for illiquid securities. Additionally, the access fee reduction in the most liquid securities would reduce incentives to route away from the exchanges. 

To better inform investors with respect to their brokers’ order handling decisions, BATS proposed that all Alternative Trading Systems (“ATSs”) should be required to provide customers with their rules of operation. This disclosure would include full descriptions of order types, pricing tiers, all forms of order-routing logic, and transparent participant eligibility guidelines. Using this information, institutional investors could better determine if a venue and/or order routing product met their trading needs. These transparency initiatives, in combination with the access fee reductions discussed above, provided a more “elegant” solution to bringing volume back to the exchanges than the “grand compromise.”

According to BATS, all exchanges and ATSs, regardless of their size, have a significant competitive advantage by virtue of the “trade through rule.” The trade through rule, under Regulation NMS, requires all market participants to do business with all execution venues that display orders to the market. BATS argues that while in some cases the marginal operating cost for a “new” exchange is near zero, market participants may incur substantial costs when trying to connect to these small venues. To combat this problem, BATS proposed a revision to Regulation NMS that provided until an exchange or other currently-protected market center achieved greater than 1% share of consolidated average daily trading volume in any rolling three-month period: (1) it should no longer be protected under the trade through rule; and (2) it should not share in/receive any NMS plan market data revenue. 

The result of implementing these provisions would serve two purposes. First, client costs in connecting to small exchanges and ATSs would potentially be reduced. This would give the small exchanges and ATSs flexibility to route around them if they chose to and also continue to protect displayed limit orders for the larger venues. Second, market data revenue that may be the basis for the continued operation of marginal venues would be taken away. 

The ultimate goal of BATS’ letter is to generate feedback from the industry as well as garner support of its proposals before sending a petition of the proposed changes to the SEC.  

The primary materials for this post are available on the DU Corporate Governance Website.

December comment letter:

Jan. 6: 

Rulemaking petition:


Court Declines to Dismiss Allegations of Material Misstatements and Omissions Surrounding Company’s IPO

In In re Fairway Group Holding Corp. Securities Litigation, 2015 BL 12688 (S.D.N.Y. Jan. 20, 2015), the District Court for the Southern District of New York granted in part and denied in part the motions to dismiss the complaint brought by Jacksonville Police and Fire Pension’s (“Plaintiff”) against Fairway Group Holding Corp. (“Fairway”), Sterling Investment Partners, et al. (“Sterling”), certain directors and officers of Fairway, and the syndicate of underwriters involved with Fairway’s initial public offering (collectively, the “Defendants”) alleging securities fraud.   The complaint specifically alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 in connection with Fairway’s initial public offering (“IPO”).

According to the allegations in the complaint, Defendants in the period preceding the IPO made certain representations about Fairway’s business in the grocery store industry, specifically regarding new store growth, same store sales growth, and deferred tax assets reported in the financial statements. Plaintiff alleged that the statements were misleading and that it relied upon the statements in purchasing stock after the IPO.   

Plaintiffs alleged that Fairway’s statements about its “proven ability to replicate its store model” and its “scalable infrastructure” indicated Fairway’s ability to continue its new store growth strategy, which failed to be true. Plaintiffs further alleged that statements about the “disruption” to sales caused by Hurricane Sandy omitted that in actuality, sales were boosted by the storm. Lastly, Fairway stated beliefs about future taxable income that were alleged to be false.  Defendants argued Plaintiff did not adequately plead a material misstatement or omission, scienter, or loss causation.

A prima facie claim under Rule 10b-5 requires allegations of “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” The Private Securities Litigation Reform Act (“PLSRA”) requires a securities fraud complaint to specify each statement alleged to have been misleading, the reasons such statements were misleading, and include the information on which such belief was formed.

Scienter refers to the required state of mind. The PLSRA requires the complaint to allege facts giving rise to a strong inference of scienter.  Plaintiff can meet the pleading standard by showing that the Defendant had the motive and opportunity to commit the alleged act or by showing  “circumstantial evidence of conscious misbehavior or recklessness.”

The court found that the IPO constituted a sufficient motive to commit fraud. Id. (“Plaintiff alleges that in misrepresenting and concealing the state of Fairway's business, defendants were able to raise millions of dollars in the offering, nearly recouping their entire $150 million investment in Fairway, "that they otherwise would not have been able to if they presented a more complete and accurate financial snapshot." ).  Further, because Defendants were officers and directors of the company with access to all the key company information, the court inferred they had ample opportunity to commit fraud.   

Additionally, the court found loss causation was inferred due to the drop in share prices following Plaintiff’s purchases of Fairway stock and the Defendants’ correction to their previous false statements. Plaintiff, therefore, adequately alleged violations of Rule 10b-5.

Section 20(a) liability arises where the defendant controls the person who commits a fraudulent act and is therefore responsible “in some meaningful sense.” Plaintiff’s claim under this section survived as to all Defendants except for Sterling Advisors, a member of Sterling Investment Partners. While the other Defendants met the elements of Section 20(a), the court found Sterling Advisors only gave advice and did not reach the needed level of control.

Finally, Sections 11 and 12 apply to omissions and misstatements of material fact in a registration statement or in a prospectus, and Section 15 assigns liability to those persons with control over anyone liable under Sections 11 or 12. The court found Plaintiff sufficiently alleged omissions and misstatements required by Section 11. It also found, however, that Section 12(a)(2) did not apply because Plaintiff did not allege that shares were acquired in the IPO. 

Ultimately, the court found Plaintiff sufficiently alleged claims under Section 10(b) and 20(a) of the Securities Exchange Act and Rule 10b thereunder, as well as Sections 11 and 15 of the Securities Act. The court also dismissed Plaintiff’s claims as to defendant Sterling Advisors and all claims under Section 12(a)(2) of the Securities Act.

The primary materials for this case may be found on the DU Corporate Governance Website.


The Second Circuit Prevents UBS from Arbitrating $350 Million Claim Against Nasdaq in Facebook IPO

In Nasdaq OMX Group, Inc. v. UBS Securities, LLC, 770 F.3d 1010 (2d. Cir. 2014), the Second Circuit Court of Appeals held defendants could not require Nasdaq OMX Group Inc. and the Nasdaq Stock Market LLC (collectively “Nasdaq”) to arbitrate claims concerning Nasdaq’s alleged mismanagement of the highly anticipated initial public offering (“IPO”) of Facebook, Inc. (“Facebook”).

According to the allegations, Nasdaq, on May 18, 2012, scheduled secondary trading for the Facebook IPO to begin at 11:00 a.m. Eastern Standard time. Technical difficulties with “Cross,” the computerized system that typically launches IPO trading by matching buy and sell orders to determine the opening price, caused a delay in the commencement of trading. As a result, over 30,000 orders entered between 11:11:00 a.m. and 11:30:09 a.m. were not included in the completed IPO Cross. Nasdaq canceled some of these orders and released the others into the market at 1:50 p.m. In addition, Cross failed to transmit certain trade confirmations for orders placed before 11:30:09 a.m. Consequently, Nasdaq members could not determine if their orders processed and what position they held in Facebook securities.

The Securities and Exchange Commission (“SEC”) initiated an investigation and ultimately brought disciplinary charges against Nasdaq. Nasdaq settled the case with the SEC and paid a civil penalty of $10 million. The SEC press release for this case can be found here.

In the aftermath of the Facebook IPO, Nasdaq amended its rules to permit the establishment of a voluntary procedure to compensate Nasdaq members injured in connection with the Facebook IPO. Defendant, UBS Securities, LLC (“UBS”), did not pursue that opportunity for relief and instead initiated an arbitration proceeding against Nasdaq under a separate services agreement for breach of contract, indemnification, breach of implied duties of good faith and fair dealing, and gross negligence and sought over $350 million in damages.

Nasdaq commenced a declaratory judgment action to prevent UBS from pursuing arbitration. On June 28, 2013, the United States District Court for the Southern District of New York ruled in Nasdaq’s favor, and UBS appealed to the Second Circuit. 

UBS contended the district court erred in exercising federal question jurisdiction in a case presenting only state law claims. UBS also contended the district court improperly concluded the court, rather than an arbitrator, should decide whether UBS’s claims were subject to arbitration. Lastly, UBS challenged the district court’s decision that its claims against Nasdaq were not arbitrable.

With respect to federal question jurisdiction, the Second Circuit observed that a court may properly exercise jurisdiction over a “special and small” category of actual state claims that present significant, disputed issues of federal law. Although UBS’s arbitration demand asserted only New York state law claims, the claims necessarily raised actually disputed issues of federal securities law. In addition, the issues presented were of substantial importance to the federal system, as a whole, and, as a result, the exercise of federal jurisdiction in these circumstances would not disrupt any federal-state balance approved by Congress.

In considering the role of the courts in resolving the issue of arbitrability, the Second Circuit relied on the premise that the law generally treated the issue as one for judicial determination “unless the parties clearly and unmistakably provide[d] otherwise.” Nasdaq and UBS were parties to a bilateral service agreement that was silent as to who should decide arbitrability. Accordingly, the Second Circuit held the district court correctly determined that it should resolve the arbitrability of UBS’s claims, rather than commit that question to an arbitrator.

The Second Circuit also affirmed the trial court’s decision that the relevant issues were not subject to arbitration. Both UBS and Nasdaq agreed their agreement to arbitrate was valid; therefore, the only issue on appeal was whether the agreement covered UBS’s claims. The Second Circuit looked to the language of the contract to define the disputes subject to arbitration. The service agreement stated the parties intended to submit all disputes to arbitration “except as provided in the Nasdaq OMX Requirements.” The “Nasdaq OMX Requirements” incorporated Nasdaq rules and rule interpretations. Because Nasdaq Rule 4626(a) forbid claims on losses experienced during trading on the exchange, the Second Circuit held that the parties could not have intended to arbitrate claims precluded by the provision.   

In conclusion, the Second Circuit Court of Appeals upheld the district court’s decision to enjoin UBS from pursuing arbitration against Nasdaq and remanded the case to the district court for further proceedings.

The primary materials for this case may be found on the DU Corporate Governance website. 



On July 21, 2014, the fourth anniversary of the Dodd-Frank Act, Democrats and Republicans on the House Financial Services Committee published separate reports regarding the law. The 30-page report prepared by Democratic members of the Committee remarked that regulators had made “tremendous progress” in implementing the Dodd-Frank Act. The Democratic report, however, claimed the Republican Majority stymied this progress through its concerted efforts to underfund regulators’ operations, pressure regulators relentlessly to weaken regulations, and otherwise erect roadblocks to implementation.  

The Democrats’ report complimented the rules put in place by regulators, including the Securities and Exchange Commission (“SEC”) and Commodity Futures Trading Commission (“CFTC”). The report applauded the Dodd-Frank Act for providing shareholders a non-binding vote to approve or disapprove executive compensation and golden parachutes. It also claimed the SEC has recovered more than $9.3 billion in civil fines and penalties since 2011, due to the increased authority the Dodd-Frank Act provided the SEC.

With respect to whistleblower enhancements in the Dodd-Frank Act, the report noted that the SEC has already received more than 6,573 tips from 68 countries. Additionally, in order to implement the Dodd-Frank Act, “the CFTC has completed 65 final rules, orders, and guidance documents resulting in the registration and enhanced oversight of 102 Swap Dealers, two Major Swap Participants, 22 Swap Execution Facilities, and four Swap Data Repositories.”

Moreover, the Dodd-Frank Act created the Consumer Financial Protection Bureau (CFPB) to ensure American consumers “get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, and protects them from hidden fees, abusive terms, and deceptive practices through strong enforcement of consumer protection laws.” The report credited the CFPB with returning $4.6 billion to 15 million consumers subjected to unfair and deceptive practices. The report praised the CFPB for creating a qualified mortgage rule that established a federal standard for all home loans to ensure borrowers can repay their loans.

Additionally, the qualified mortgage rule prohibited lenders from receiving financial rewards for subprime loans that encouraged lenders to steer borrowers into more expensive loans. This included prohibitions on “yield, spread premiums” that lenders provided brokers to encourage the origination of riskier loans to borrowers, especially minorities, who otherwise qualified for superior loans. The Democrats’ report also praised the implementation of the Volcker Rule that limits financial institutions receiving government assistance, proprietary trading and investment in and sponsorship of hedge funds and private equity funds. Because of the Volcker Rule, “banks have shifted away from speculative trading to investments in the real economy.” 

Despite this progress, the Democratic report accused the Republican Majority of engaging in a campaign to repeal, weaken, or otherwise pressure regulators to significantly modify provisions in almost all of the titles of the Dodd-Frank Act. The report also alleged the Republican Majority underfunded regulators like the SEC and CFTC and subjected their rulemakings to constant implementation hurdles. For example, the report stated the Republican Majority passed bill H.R. 2308 in the 112th Congress and H.R. 1062 in the 113th Congress that would subject SEC rulemakings to stricter cost-benefit standards. Moreover, the report criticized the bills for not providing further funding to the SEC, even though the bills would require significantly more resources for economic analysis before the SEC could issue rulemakings. In addition, the report stated the Republican Majority refused to adequately increase the funding of the SEC and CFTC despite the fact their responsibilities increased under the Dodd-Frank Act. The report cautioned, “[i]f enacted, the cumulative effect of these efforts would render the Dodd-Frank Wall Street Reform and Consumer Protection Act essentially toothless, inviting a return to the opacity, risk, and deregulation that caused the 2008 crisis.” 

The Democratic report concluded that since the Dodd-Frank Act’s passage, increased stability in the market has led to economic growth. The report indicated that the private sector created almost 9.7 million payroll jobs since February 2010. In addition, unemployment is now at 6.1 percent, its lowest level since September 2008. Moreover, real GDP growth now stands 5.5 percent higher than its pre-recession high in late 2007. Nevertheless, the Democrats’ report called the Republican Majority a roadblock in regulators’ Dodd-Frank Act implementation progress.  

The primary materials for this case may be found on the DU Corporate Governance website. 


The Curious Case of Etsy

Etsy has just gone public.  Prices on the first day doubled.  The DealBook wrote a story suggesting that Etsy was only the second (and by far the largest) B Corporation to go public.  See Etsy I.P.O. Tests Pledge to Balance Social Mission and Profit.  As the article noted: 

  • Etsy is one of a growing number of companies, called B Corps, that pledge to adhere to social and environmental accountability guidelines set by a nonprofit organization called B Lab. And Etsy on Thursday became only the second for-profit company to go public out of more than 1,000 companies that have that certification.

Etsy is a B Corporation, having been certified as such (Etsy was certified in 2012).  But as the article pointed out, Etsy is in fact not incorporated under the benefit corporation statute in the state of incorporation (in this case, Delaware).  Id. ("B Lab is giving companies four years from the date any relevant state legislation is passed to comply with the state law or risk losing B Corp certification.").  In fact, Esty is incorporated in Delaware as a traditional corporation.  The articles are here.  The bylaws are here.

As a result, directors have traditional fiduciary duties to shareholders.  They may not, legally, dispense with the obligations to shareholders in order to benefit the community.  The S-1, therefore, was very careful to discuss community obligations as a long term benefit to the corporation.  The Form S-1 is here

As the S-1 stated: 

  • Adherence to our values and our focus on long-term sustainability may negatively influence our short- or medium-term financial performance.  Our values are integral to everything we do, and accordingly, we intend to focus on the long-term sustainability of our business and our ecosystem. We may take actions that we believe will benefit our business and our ecosystem and, therefore, our stockholders over a period of time, even if those actions do not maximize short- or medium-term financial results. However, these longer-term benefits may not materialize within the timeframe we expect or at all. For example: 
  • we may choose to prohibit the sale of items in our marketplace that we believe are inconsistent with our values even though we could benefit financially from the sale of those items;
  • we may choose to revise our policies in ways that we believe will be beneficial to our members and our ecosystem in the long term even though the changes are perceived unfavorably among our existing members;
  • or we may take actions, such as investing in alternative forms of shipping or locating our servers in low-impact data centers, that reduce our environmental footprint even though these actions may be more costly than other alternatives.

So, as currently configured, Etsy has the same fiduciary obligations as other corporations.  In that sense, investors are taking no greater risk than with any other investor in any other corporation, at least with respect to the legal obligations of directors. 

Indeed, Etsy apparently has five years to reincorporate as a B Corporation to maintain its B Corporation status.  The S-1 contained no commitment with respect to that step and, to the exent the board considers the issue, it will have to determine that amending the articles is in fact in the best interests of shareholders (rather than the community). 


Assistant Director of the Center for Transactional Law and Practice (Emory Law School)

Per Dean Bobby Ahdieh:  "Emory is expanding the leadership of its growing Transactional Law Program – previously headed by Tina Stark and Carol Newman, and now led by Sue Payne.  See the announcement below.”

Emory Law School seeks an Assistant Director of the Center for Transactional Law and Practice to teach in and share the administrative duties associated with running the largest program in the Law School.  Each candidate should have a J.D. or comparable law degree and substantial experience as an attorney practicing or teaching transactional law.  Significant contacts in the Atlanta legal community are a plus. 

Initially, the Assistant Director will be responsible for leading the charge to further develop the Deal Skills curriculum.  (In Deal Skills – one of Emory Law’s signature core transactional skills courses – students are introduced to the business and legal issues common to commercial transactions.)  The Assistant Director will co-teach at least one section of Deal Skills each semester, supervise the current Deal Skills adjuncts, and recruit, train, and evaluate the performance of new adjunct professors teaching the other sections of Deal Skills

As the faculty advisor for Emory Law’s Transactional Law Program Negotiation Team, the Assistant Director will identify appropriate competitions, select team members, recruit coaches, and supervise both the drafting and negotiation components of each competition.  The Assistant Director will also serve as the host of the Southeast Regional LawMeets® Competition held at Emory every other year. 

Additionally, the Assistant Director will be responsible for the creation of two to three new capstone courses for the transactional law program.  (A capstone course is a small, hands-on seminar in a specific transactional law topic such as mergers and acquisitions or commercial real estate transactions.)  The Assistant Director will identify specific educational needs, recruit adjunct faculty, assist with curriculum design, and monitor the adjuncts’ performance.   

Besides the specific duties described above, the Assistant Director will assist the Executive Director with the administration of the transactional law program and the Transactional Law and Skills Certificate program.  This will involve publicizing the program to prospective and current students, monitoring the curriculum to assure that students are able to satisfy the requirements of the Certificate, and counselling students regarding their coursework and careers.  The Assistant Director can also expect to participate in strategic planning, marketing, fundraising, alumni outreach, and a wide variety of other leadership tasks. 


Emory University is an equal opportunity employer, committed to diversifying its faculty and staff.  Members of under-represented groups are encouraged to apply.  For more information about the transactional law program and the Transactional Law and Skills Certificate Program, please visit our website at:

To apply, please mail or e-mail a cover letter and resumé to: 

Kevin Moody

Emory University Law School

1301 Clifton Road, N.E.

Atlanta, GA  30322-2770




Khazin v. TD Ameritrade Holding Corporation: Dodd-Frank Whistle-Blower Must Arbitrate Reprisal Claims

In Khazin v. TD Ameritrade Holding Corp., 773 F.3d 488 (3d Cir. 2014), the United States Court of Appeals for the Third Circuit (the “Court of Appeals”) affirmed the district court’s holding, which dismissed Boris Khazin’s (“Khazin”) Dodd-Frank retaliation claim against TD Ameritrade Holding Corp., TD Ameritrade Inc., Amerivest Management Co., and Luke Demmissie (collectively “TD”). In addition, the Court of Appeals affirmed the district court’s holding, which compelled arbitration pursuant to a predispute arbitration agreement between Khazin and TD. The Court of Appeals concluded that Khazin’s claim did not qualify for the statutory exemption from the arbitration agreement with TD.

According to the factual allegations, Khazin worked for TD providing professional financial services and performing due diligence on the company’s outgoing financial products. Khazin signed an agreement with TD, agreeing to arbitrate any dispute related to his employment. After discovering the price of one of TD’s products failed to comply with applicable securities regulations, Khazin suggested a price change to his supervisor, Demmissie. Upon learning that the proposed price change would result in a loss of $1,150,000 in revenue, Demmissie allegedly instructed Khazin to discontinue communication about the pricing violation and informed Khazin that TD would not make the price change. Khazin’s employment was later terminated for a supposed billing inconsistency.

Khazin filed suit in New Jersey state court, alleging violation of both state law and the Dodd-Frank Act. After the court dismissed his claims without prejudice for lack of subject matter jurisdiction, Khazin brought a whistleblower claim under the Securities Exchange Act.  See 15 U.S.C. § 78u-6(h).  TD then filed a motion to dismiss and to compel arbitration in accordance with the arbitration agreement between Khazin and TD.

In its motion, TD argued the anti-arbitration provision in the Dodd-Frank Act, which provided an exemption from predispute arbitration agreements (“Anti-Arbitration Provision”), did not apply to claims brought under 15 U.S.C. § 78u-6(h), and therefore did not shield Khazin from his contractual obligation to arbitrate the dispute. As an alternative, TD argued Dodd-Frank’s Anti-Arbitration Provision did not provide retroactive exemption from an arbitration agreement signed, as in Khazin’s case, prior to the enactment of the Act. 

The district court held the Anti-Arbitration Provision did not invalidate arbitration agreements executed prior to the passage of Dodd-Frank. Consequently, the court granted TD’s motion to dismiss and compelled Khazin to arbitrate.  Khazin appealed, arguing the Anti-Arbitration Provision and the essence of the Dodd-Frank Act rendered his arbitration agreement unenforceable.

SOX created protection for whistleblowers and provided them with a private right of action.  See 18 U.S.C. § 1514A.  Dodd-Frank included provisions that prohibited employer retaliation against whistleblowers.  The Act included a private right of action for violations of the anti-retaliation provision.  See 15 U.S.C. § 78u-6(h).  In addition, the Act provided that “[n]o predispute arbitration agreement shall be valid or enforceable, if the agreement requires arbitration of a dispute arising under this section.” 18 U.S.C. §1514A(e)(2).  

The Court of Appeals held that the anti-arbitration provision applied only to actions under 18 U.S.C. §1514A and not actions under 15 U.S.C. § 78u-6(h).  In doing so, the Court relied on the language of the Anti-Arbitration Provision and the structure of the Act.

First, the Court of Appeals reasoned that the phrase “arising under this section” in 18 U.S.C. §1514A(e)(2) expressly limited the application of the Anti-Arbitration Provision to disputes arising under SOX.  Because Khazin’s claim arose under Dodd-Frank, the court held the Anti-Arbitration Provision was not applicable.  

The Court of Appeals also found the structure of the Dodd-Frank Act particularly relevant, noting that Congress did not add an anti-arbitration provision to the Dodd-Frank cause of action but simultaneously appended anti-arbitration provisions to claims arising under various other sections. Thus, the Court of Appeals determined that Congress deliberately excluded Dodd-Frank claims from anti-arbitration protection, despite Khazin’s argument that the omission was inadvertent. Consequently, the Court of Appeals affirmed, though on different grounds, the district court’s order dismissing Khazin’s claim and compelling arbitration pursuant to his employment agreement. 

The primary materials for this post can be found at the DU Corporate Governance website


SEC v. Epstein: Epstein’s Ill-Gotten Gains

In SEC v. Epstein, No. 2:15-cv-00506-WB (E.D. Pa. Feb. 3, 2015), the Securities and Exchange Commission (the “SEC”) filed a complaint in the United States District Court of Pennsylvania against Joel Epstein (“Epstein”) for gains allegedly acquired through insider trading. Epstein consented to an entry of final judgment for violations of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”).

The SEC alleged that Epstein learned from his son about the impending merger between Nationwide Mutual Insurance Company (“Nationwide”) and Harleysville Group, Inc. (“Harleysville”) in early September 2011. His son allegedly received the confidential information from his girlfriend, who was a legal assistant for a law firm helping Harleysville with the merger. The complaint described their relationship as one of trust and confidence. Once Epstein acquired this information, the complaint asserted that he told his son, “don’t ever mention this again” and “we never talked.” Complaint ¶ 23 at 4, SEC v. Epstein, No. 2:15-cv-00506-WB (E.D. Pa. Feb. 3, 2015). Epstein also alleged to have informed four other people, who in turn purchased 1,000 shares each.

Epstein acquired 4,000 shares in Harleysville stock. On September 29, 2011, Nationwide announced an intent to “acquire all publicly-traded shares of Harleysville for $60 per share” or approximately $760 million. Harleysville’s stock price rose by 87%. Shortly thereafter, Epstein sold his shares.

Rule 10b-5 under the Exchange Act prohibits anyone from engaging in acts or omissions that result in securities fraud. Epstein consented to an injunction for violations of the provision. The injunction required the payment of disgorgement of $237,014—the total of ill-gotten gains acquired by Epstein and his four tippees’—plus $21,599 prejudgment interest and $237,014 in civil penalties. The SEC’s investigation is ongoing.

The primary materials for this case may be found on the DU Corporate Governance website. 


Fisher v. Tails: Supreme Court of Virginia Denies Appraisal Rights to Minority Shareholders, Holds Delaware Corporate Law Trumps Step Transaction Doctrine

In Fisher v. Tails, Inc., 767 S.E.2d 710 (Va. 2015), the Supreme Court of Virginia held that the minority shareholders of a Virginia corporation which re-incorporated in Delaware prior to selling all of its assets were not entitled to Virginia appraisal rights under the “step transaction doctrine.”

Tails, Inc., formerly a Virginia corporation, consummated a four-step transaction pursuant to a purchase agreement with Buena Suerte Holdings, Inc. in which, during a two day period: (1) Tails, Inc. reincorporated from Virginia to Delaware; (2) Tails, Inc. merged with Tails, LLC, a Delaware entity owned by Tails Holdco, Inc.; (3) Tails, LLC amended and restated its LLC agreement “to remove certain limited liability company provisions”; and (4) Tails Holdco, Inc. sold the entirety of its interest in Tails, LLC to Buena Suerte Holdings, Inc.

Shareholders approved the four step transaction at a special meeting. The minority shareholders (holding 21% of the shares) voted against the relevant proposals. The minority shareholders asserted that they were entitled to appraisal rights because the transaction amounted to an asset sale.

In seeking appraisal rights, shareholders argued for application of the “step transaction” doctrine or the “equitable substance over form” doctrine. Under the step transaction doctrine, multiple steps can be construed to be part of a unitary transaction. The equitable substance over form doctrine allows relief to be granted to parties harmed by legal practices that create unfair results.

The Supreme Court of Virginia assumed without deciding that the doctrine applied. The Court recognized that the step transaction and substance over form doctrines were intended to “prevent transactional formalities from blinding the court to what truly occurred” and “allow a court to look beyond form to the substance of a transaction.” The Court found, however, that the doctrine was designed to prevent the use of equitable principles “to recharacterize actions of defined legal significance.” It could not be used, however, to “second guess” the explicit application of a statutory requirement; the statute under which a transaction is effected will govern that transaction.

Virginia law allows corporations to domesticate in other jurisdictions and provides that the laws of the new jurisdiction govern after that point. Virginia Code § 13.1-722.2. Moreover, domestication is not an event that triggers appraisal rights. As a result, the Court declined to find that the properly conducted domestication of a Virginia corporation should be combined with subsequent transactions for purposes of determining the applicability of appraisal rights. The Court also found that, because the subsequent steps took place in Delaware, shareholders were not entitled to appraisal rights under the laws of that state.

The primary materials for this post can be found on the DU Corporate Governance website.


Merion v. BMC: Share-Tracing Requirements Rejected for Appraisal Petitioners

Merion Capital LP and Merion Capital II LP (together, “Merion”) filed a petition for appraisal of stock in the Court of Chancery of Delaware under Section 262 of the Delaware General Corporation Law after acquiring over seven million shares of BMC Software, Inc. (“BMC”). Merion Capital LP & Merion Capital II LP v. BMC Software, Inc., No. 8900-VCG, 2015 BL 579 (Del. Ch. Jan. 05, 2015). BMC argued § 262 precluded Merion’s standing and moved for summary judgment. The court denied BMC’s motion for summary judgment and found Merion had perfected its appraisal rights in BMC’s common stock.

BMC, a Delaware corporation, entered into an Agreement and Plan of Merger (“Merger Agreement”) with Boxer Parent Company, Inc. and its wholly owned subsidiary Boxer Merger Sub Inc. (together, “Boxer”). Boxer was to acquire BMC for $46.25 per share of common stock. Merion acquired 7,629,100 shares of BMC common stock through a series of broker purchases on the public market after determining that the consideration offered in the BMC/Boxer merger undervalued the company. Merion then sought to issue a demand for appraisal of its BMC common stock.

Under § 262, “only the record holder of shares can make the statutorily required demand for appraisal on the corporation.” Merion’s broker refused to direct the record holder, Cede & Co. (“Cede”), to issue a demand for appraisal. As a result, Merion became the record holder of its shares by having its holdings in BMC stock withdrawn from Cede and registered directly with BMC’s transfer agent. Merion then issued an appraisal demand on BMC prior to the stockholder vote on the proposed Merger Agreement. More than two-thirds of the BMC stockholders voted in favor of the merger. 

Merion filed a Verified Petition for Appraisal of Stock to perfect its right to have its shares of BMC common stock appraised by the court. BMC then moved for summary judgment and argued § 262 required proof that each share Merion sought to have appraised was not voted by any previous owner in favor of the merger.

Interpreting the statute according to its plain language, the court determined the petitioner “need only show that the record holder of the stock for which appraisal is sought” held the shares on the date it made a demand for appraisal; continuously held the shares through the effective date of the merger; delivered a timely written demand for appraisal to the corporation before a stockholder meeting to vote on the merger was held; and has not voted in favor of the merger. The court refused to impose share-tracing requirements rejecting BMC’s argument that the legislative purpose favored the imposition of the requirement. Additionally, the court found the statute was “meant to enhance, not limit, rights to appraisal.”

With no dispute as to the material facts of the case the court found Merion, as a matter of law, satisfied all of the standing requirements set forth in § 262. Therefore, the court denied BMC’s motion for summary judgment and held Merion perfected its right to have its shares of BMC stock appraised by the court.

Primary materials for this case may be found on the DU Corporate Governance website.


Special Projects Segment: Opposition to Adopting Crowdfunding Rules

We are discussing possible rulemaking for equity crowdfunding under the JOBS Act.

On October 23, 2013, the U.S. Securities and Exchange Commission (“SEC”) proposed the Crowdfunding Rules (the “Proposed Rules”), which were drafted in connection with Title III of the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”). Title III allows private equity crowdfunding involving non-accredited investors. The SEC intends to protect investors against fraudulent offerings while facilitating capital raising under the Proposed Rules.

While many commenters support at least some aspects of the Proposed Rules, a number of corporations, crowdfunding organizations, law firms, legislators, and academics are concerned that the Proposed Rules will be ineffective in providing the investor protections intended by Congress. Ernst & Young, LLP expressed concern in its comment letter that the Proposed Rules will not benefit small businesses because a company could only crowdfund a maximum aggregate amount of $1 million in a 12-month period, which is arbitrary and unnecessarily low, limiting rather than facilitating capital raising.

EarlyShares, a smaller crowdfunding platform, echoed the concern raised by Ernst & Young and further expressed in its comment letter the need for significant modifications to the Proposed Rules in order to make them more transparent and beneficial to all participants. EarlyShares stated the expense and time required for an issuer to comply with the financial disclosures and ongoing reporting requirements “should be reduced and proportionate with the capabilities of the issuers.” EarlyShares suggested that the cost and burden of disclosure and reporting be balanced against an issuer's interest in protecting sensitive and proprietary data. Without balancing the costs and burdens, EarlyShares forewarned the Proposed Rules may deter companies from engaging in crowdfunding campaigns.

CrowdCheck, Inc., a disclosure and due diligence service provider for early-stage companies, submitted its comment letter seeking clarity as to the specific disclosure requirements. CrowdCheck also requested that “free writing” disclosures be permitted. In support of its immediate online disclosure recommendation, CrowdCheck relied mostly upon the substantial costs and burdens that small businesses would face in order to create a “text-heavy, private placement memorandum” for the offering. CrowdCheck further relied upon the fact that frequent disclosures may be required in response to the “wisdom of the crowd.” Because material disclosures may be frequent, costly, and likely in a file format that is incompatible with EDGAR, CrowdCheck urged the Commission to consider free writing disclosures.

These comment letters highlight how the Proposed Rules do not fulfill the congressional intent to help small businesses raise capital, a sentiment that is reiterated by many commenters. Crowdfunding is popular, in part, because of the low barriers to entry. Under the Proposed Rules, however, many commenters fear that issuers will face significant upfront costs, mandatory information disclosures, and numerous barriers to raising capital. If the costs and burden are not balanced with small business interests, then the possibility of a failed offering increases, leaving the organization in a worse position. It is also possible that extraordinary costs will prevent offerings from happening at all. If safeguards are not embedded to better protect all participants from associated high costs and financial risks, many organizations and individuals may be deterred from utilizing this form of equity crowdfunding. 


Securities and Exchange Commission v. Braverman Update

This post is a continuation of a series of posts tracking SEC v. Braverman, 14CV7482–RMB, (S.D.N.Y.).

On September 16, 2014, the United States District Court for the Southern District of New York entered an order temporarily freezing Dimitry Braverman and Vitaly Pupynin’s assets (the “Order”) in connection to a suit brought by the Securities and Exchange Commission (“SEC”).   The SEC alleged Braverman and Pupynin committed fraud and violated the securities laws.

The United States Attorney’s Office for the Southern District of New York also brought criminal charges against Braverman for alleged insider trading. On November 13, 2014, Braverman pleaded guilty to one count of securities fraud in the criminal case. Braverman’s sentencing is scheduled for March 6, 2015, but his counsel sought an extension for May 2015. The Government has stipulated to the extension, and both parties await the courts ruling in the criminal case. 

On November 19, Braverman and the SEC submitted a third Stipulation and Proposed Order to the court to request new briefing dates in connection with the Order. The parties made this request for an adjournment because of discussions between Braverman and the SEC about potential resolution of the SEC charges. The court entered the Stipulation and Proposed Order extending the parties time to respond to the Order due to the potential for a resolution to narrow or eliminate future litigation related to the asset freeze. The Order remains in effect pending a hearing on the SEC’s Application for the asset freeze. The next hearing is set for February 19, 2015.

The primary materials for this case may be found on the DU Corporate Governance website.



Doshi v. Gen. Cable Corp.: Creating an Inference of Scienter Requires Particularized Facts in Failure to Discover Complex Theft Scheme

In Doshi v. Gen. Cable Corp., No. 2:14-cv-22 (WOB-CJS), 2015 BL 19141 (E.D. Ky. Jan. 27, 2015), the United States District Court for the Eastern District of Kentucky held that City of Livonia Employees’ Retirement System and others similarly situated (“Plaintiffs”) failed to state a claim for failing to allege a strong inference of scienter.

According to the allegations in the complaint, Plaintiffs bought stock in General Cable Corporation over a three-year period. During the period, an inventory theft scheme occurred in an international subsidiary.  General Cable eventually issued two restatements in order to correct the accounting errors resulting from the scheme. Following the corrections, General Cable’s stock price declined. Plaintiffs filed suit, alleging General Cable’s senior executives (“Defendants”) “knew or recklessly disregarded that adverse facts had not been disclosed.” 

To prevail on a claim under Section 10(b) of the Exchange Act or Rule 10b-5 thereunder, a plaintiff must prove that the misstatement or omission was made with scienter. Scienter is a mental state that entails an “intent to deceive, manipulate, or defraud.” An inference of recklessness can arise from “multiple, obvious red flags.” Federal Rule of Civil Procedure 9(b) requires a fraud allegation to be stated with particularity, and the Private Securities Litigation Reform Act (“PSLRA”) requires a plaintiff to “state with particularity facts giving rise to a strong inference” the defendant acted with scienter. The inference of scienter must be as compelling as any other opposing inference drawn from the same set of facts. 

The existence of restatements can create an inference of scienter. Those restatements, however, must demonstrate clear accounting errors that are “‘drastic,’ ‘pervasive,’ and ‘egregious.’” The mere existence of a restatement, without any further evidence, does not create an inference of the necessary intent. Where the fraud occurs in a subsidiary, “courts should not ‘presume recklessness or intentional misconduct from a parent corporation's reliance on its subsidiary's internal controls.’” Corporate scienter can be imputed from “lower-level employees” who contribute to the misstatement but the complaint must nonetheless allege adequate facts “that give rise to a strong inference of fraudulent intent” by those individuals.     

In this case, the complaint failed to allege any particularized facts that would create an inference of scienter. Among other things, the magnitude of the restatements did not constitute sufficient evidence of scienter. The financial impact of the corrections involved only 0.3% of the company’s sales.

In discounting the duration of the errors as evidence of the necessary intent, the court reasoned that “the duration of the errors speaks less to Defendants' states of mind and more to the thieves' sophistication.” The court also found insufficient to establish scienter the allegations that Defendants had access to information that would allow for discovery of the scheme; Defendants had to make multiple restatements; and Defendants’ internal controls were insufficient. Plaintiffs did not “specify any instance where Defendants gained relevant knowledge . . . and disregarded it.”

Nor was the reliance by the parent on the financial and internal control systems of the subsidiary sufficient to show scienter.   The court stated “that courts should not ‘presume recklessness or intentional misconduct from a parent corporation’s reliance on its subsidiary’s internal controls.’” Furthermore, a mistake that is evident in hindsight does not provide evidence of scienter. It is also common for a parent company not to manage a seemingly successful subsidiary. Lastly, Plaintiffs did not allege any facts related to the purpose of concealing fraud.

The United States District Court for the Eastern District of Kentucky held Plaintiffs’ complaint failed to support a strong inference of scienter. Accordingly, the court granted General Cable’s motion to dismiss, dismissing Plaintiffs’ claims with prejudice.

The primary materials for this post can be found on the DU Corporate Governance website.


Dailey v. Medlock Securities Fraud Complaint Dismissed by Sixth Circuit 

In Dailey v. Medlock, 551 Fed.Appx. 841 (6th Cir. 2014), the Sixth Circuit Court of Appeals held the plaintiffs’ complaint failed to state an actionable federal securities fraud claim under F.R.C.P. 9(b) or the heightened pleading standards of the Private Securities Litigation Reform Act (PSLRA). 

According to the complaint, Community Central Bank Corporation solicited investors to purchase private stock in Community Central Bank (CCB) through a Private Placement Memorandum (PPM) dated July 2009. On October 19, 2009 and December 16, 2009, Community Central Bank Corporation issued supplements increasing the offering to $5 million and extending the purchase period.

Plaintiffs, a group of twenty-one investors, purchased CCB stock on December 31, 2009 and January 29, 2010. Shortly thereafter, on March 29, 2010, the Michigan Office of Financial and Insurance Regulation (OFIR) issued a report finding CCB violated laws, rules, and regulations.  Two days later, CCB reported $10 million in fourth quarter losses for 2009. Much of the operating loss came from a valuation allowance on CCB’s net deferred tax assets. CCB described the valuation allowance as a “one time non-cash charge to federal income tax expense.”

Near the end of 2010, CCB entered into a Consent Order with the FDIC and OFIR. Under the Order, CCB agreed to amend its business practices without admitting or denying any violations of law, rule, or regulation. In April 2011, CCB failed and went into receivership. In February of 2012, the plaintiffs filed their complaint against 13 individual CCB officers and directors alleging violations of the federal securities laws.    

To establish a violation under §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, a plaintiff must allege that a defendant made a material misrepresentation or omission with scienter and the plaintiff’s reliance on the material misrepresentation or omission resulted in the plaintiff’s economic loss.  An omission is actionable if necessary to ensure that a statement made by the company does not mislead the market.

F.R.C.P. 9(b) requires a plaintiff to plead claims brought under §10(b) sounding in fraud with heightened particularity. In addition, the PSLRA requires a plaintiff to plead with particularity facts giving rise to the belief the statements made were misleading and facts giving rise to a strong inference the defendant acted with scienter. 

A plaintiff pleading scienter must provide facts demonstrating a strong inference the defendant acted with the intent to deceive, manipulate, or defraud the plaintiff. A plaintiff adequately pleads scienter under the PSLRA if a reasonable person would consider the inference of scienter as convincing as any other plausible opposing inference. A misstatement or omission is material if a reasonable investor would view the omitted fact as significantly altering the total mix of information made available.

The plaintiffs alleged three categories of misstatements or omissions made by the defendants violated Rule 10b-5. First, the plaintiffs argued that a statement in the PPM indicated CCB maintained adequate levels of capital throughout 2009. Plaintiffs alleged this implication was misleading because the defendants knew CCB would take the valuation allowance at the end of 2009 and the defendants failed to disclose the information in the PPM or its supplements. 

The Sixth Circuit held that the plaintiffs failed to plead any highly particularized facts to support their assertion that the defendants knew about the valuation allowance when they issued the PPM and its supplements. The court further noted that one-month before the plaintiffs purchased the stock, CCB filed a Form 10-Q with the SEC for the third quarter indicating CCB would not take a valuation allowance for that quarter. The 10-Q also stated that a valuation allowance might be necessary in the future, which could adversely affect CCB’s financial position. The court rejected the plaintiffs’ claim that the valuation allowance itself was evidence of the defendants’ prior knowledge. Consequently, the Sixth Circuit concluded that the plaintiffs’ allegations regarding the defendants’ prior knowledge of the valuation allowance failed to state a securities fraud claim under Rule 10b-5. 

Second, the plaintiffs alleged CCB misled investors by describing CCB as “well capitalized” in the PPM and three SEC filings between May and November of 2009. The plaintiffs alleged using this term misled investors because the defendants failed to disclose that CCB was engaged in risky business practices that were later investigated by the OFIR. The court noted that the term “well capitalized” is a term of art under federal banking regulations and did not relate to a general assessment of CCB’s business practices. The plaintiffs did not argue that CCB failed to meet the definition of “well capitalized” under the applicable regulatory criteria. The Sixth Circuit emphasized that the PPM stated CCB was “well capitalized” pursuant to “applicable regulatory capital guidelines.” The PPM further stated that the purpose of the stock offering was to improve CCB’s capital levels in light of a poor economic forecast. In addition, the PPM included a twenty-three page detailed discussion of the risks related to CCB’s business. Lastly, the court noted that CCB accurately reported itself as “adequately capitalized” in its Fourth Quarter filings of 2009 when CCB’s status changed. Therefore, the Sixth Circuit concluded the plaintiffs’ allegation that the defendants misled investors by describing CCB as “well capitalized” failed to state a claim under Rule 10b-5.    

Finally, the plaintiffs argued that the PPM’s statement that CCB’s operations were subject to extensive regulation by federal, state, and local governments was misleading because the defendants did not disclose they were violating laws and regulations and were under investigation by the OFIR. The plaintiffs did not plead with particularity what law or regulation the defendants violated. The Sixth Circuit noted the statement was factually accurate.  The PPM did not represent that CCB believed it was compliant with the law.  Under Sixth Circuit precedent, a nonspecific claim of legal compliance did not constitute an actionable claim for misrepresentation under Rule 10b-5 and did not require disclosure of purported illegal activity by a company. Accordingly, the Sixth Circuit held the plaintiffs failed to adequately plead an actionable Rule 10b-5 claim.

The Sixth Circuit went on to dismiss plaintiffs’ claim under §20(a) of the Exchange Act for control person liability, because the plaintiffs failed to state the requisite underlying claim for securities fraud under Rule 10b-5.  

In conclusion, the Sixth Circuit Court of Appeals upheld the district court’s decision to dismiss the plaintiffs' federal securities fraud claims.  

The primary materials for this case may be found on the DU Corporate Governance website. 


In re Nine Systems: Court Finds Breach of Fiduciary Duty Despite Fair Price 

In In re Nine Systems Corporation Shareholders Litigation, Consol. C.A. No. 3940-VCN., 2014 BL 245208 (Del. Ch. Sept. 4, 2014), the Court of Chancery of Delaware considered a challenge to a recapitalization brought against, among others, a controlling group of shareholders and four directors of Nine Systems (collectively “Defendants”). The court determined Defendants breached their fiduciary duties by engaging in a recapitalization that was not entirely fair due to the “grossly inadequate process.” The court, however, found Plaintiffs received a “fair price” and were therefore not entitled to monetary damages. Nonetheless, the court granted leave to submit a petition for attorneys’ fees and costs.

Plaintiffs’ claims turned on the 2002 recapitalization (the “Recapitalization”) of a start-up company—Streaming Media Corporation, later known as Nine Systems Corporation (the “Company”). During the Recapitalization, the controlling shareholders increased their equity through the acquisition of convertible preferred shares, resulting in the dilution of Plaintiffs’ ownership percentage from 26% to 2%. In November 2006, Akamai Technologies, Inc. (“Akamai”) purchased the Company for approximately $175 million. Plaintiffs argued the Recapitalization was unfair and sought over $130 million in damages.

In order for Plaintiffs to have standing to challenge the recapitalization as a direct claim, they needed to establish the presence of a control group—the functional equivalent of a controlling shareholder. Collectively, a group of shareholders may be considered a controlling shareholder.  Plaintiffs had the burden of showing the group of shareholders were connected in a significant way and were working together towards a mutual goal. The court found that the circumstances surrounding a “right to invest” provided to an investor prior to the recapitalization demonstrated the presence of a control group.  The court stated: “Particularly in light of Catalyst’s earlier comments in the Catalyst Memo, this conduct here demonstrates an agreement, arrangement, and legally significant relationship among Wren, Javva, and Catalyst—who together owned a majority of the Company’s stock—to accomplish the Recapitalization. Thus, as controlling shareholders, they owed fiduciary duties to the other shareholders in the Company.

As an alternative ground, the court examined whether Plaintiffs had standing to challenge the Recapitalization under the theory that the majority of the directors were impermissibly conflicted. The court acknowledged that, “while reasonable minds disagree,” plaintiffs could also “establish standing by proving that a majority of the Board was conflicted—here, meaning interested or not independent—when it approved and implemented the Recapitalization.” Analysis of independence must occur on a director-by-director basis. Plaintiffs established that four of the directors had a fiduciary relationship with their respective entities and therefore faced a potential conflict of interests in any given transaction with the Company. The court found that it was “undisputed” that two of the directors had an incentive “to maximize the value of their investment, while the stockholders who did not participate in the Recapitalization—including the Plaintiffs—would seek to act in the best interests of the Company.” The court determined a third director also faced a “dual fiduciary problem” although not as readily apparent as the others. As a result, the Plaintiffs had “direct standing to challenge the Board’s conduct in the Recapitalization.”  

In examining the recapitalization, the court found an absence of “fair process.” Dwyer, the majority owner of one of the shareholders, “alone calculated” the value of the Company. The Board apparently had no significant role in the process.  And “[n]o independent valuation was solicited.” Moreover, the terms of the Recapitalization changed between board approval and implementation, something that “compound[ed] the evidence leading to a conclusion of unfair dealing.” Stockholders were notified of the Recapitalization, but “that document was materially misleading.” 

Although finding unfair dealing, the court nonetheless concluded the price paid in the Recapitalization was fair. Expert testimony showed that the Company’s equity had no value before the Recapitalization. Thus, the court concluded that the Recapitalization approved by a majority of conflicted directors was nonetheless at a fair price.

Although fair, the court determined that the absence of adequate process resulted in a violation of fiduciary duties. In awarding damages, the court concluded that it would be inappropriate to award disgorgement, recessionary, or other monetary damages to Plaintiffs because the “unfair Recapitalization” was effected at a fair price and any damages would be speculative in nature.  The court, however, granted Plaintiffs leave to petition the court for an award of attorneys’ fees and costs.

The primary materials for this case may be found on the DU Corporate Governance website